Analysts may be asking too much of Adobe

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Analysts are expecting Adobe to have a big year this year, breaking out of the recent earnings malaise that the company has been experiencing, followed by stellar growth next year, as well. But it may be a good idea to temper expectations.

What we want to do is identify the fair value of Adobe
ADBE, -0.69%
given current and future earnings-growth expectations. Our identification of earnings growth focuses on trailing 12-month data compared year over year every quarter and plotted over time to define yearly growth trends. We exclude one-time events to focus on truer growth rates while observing PE multiples and PEG ratios to define value.

According to our observations of fair value for Adobe, the company has had a negative growth rate since the fourth quarter of 2012, whose trough thus far was in the third quarter of 2013. In the third quarter of 2013 the yearly growth rate for Adobe was -35%. Since then, the growth rate has improved, and as of the most recent report, the yearly earnings growth rate at Adobe was -2.27%.

If analysts are right about their estimates for this coming release (March 17) that trend is likely to stay intact, and if analysts are right about their expectations for this year, the earnings growth rate for Adobe will likely increase to 9.63%. That is relatively attractive from a growth rate perspective. What's even more attractive is the ongoing growth rate if analysts are also right about earnings growth in 2016. Analysts are expecting earnings growth in 2016 of over 150% as it stands today.

At the same time, lofty PE multiples that are pushing 60 times earnings make investors scratch their heads. Adobe looks expensive today, and it will look expensive tomorrow and at the end of the year, as well, if analysts are correct about their estimates, and will only get back down to a multiple in the low 20s again at the end of 2016 if analysts are correct and price remains the same. By the end of 2015, the multiple is expected to fall to 37 times earnings if analysts are correct and price remains the same, and fall again to 23.81 times earnings by the end of 2016 assuming the same.

Unfortunately, the associated peg ratios that exist for Adobe at this time are somewhat difficult to draw conclusions from given the negative values that exist and the astronomical growth that is expected in 2016, but this does leave an ongoing concern, and that is the company's ability to meet estimates. If Adobe fails to match analysts' estimates for 2015 and 2016, a company that already looks extremely expensive on a PE-multiple basis will look even more expensive given what will surely be adjusted forward-looking guidance. Currently, the guidance and forward estimates make the future growth look impressive, but at first glance, the 150% expected growth rate for Adobe in 2016 does seem excessive.

Technical take

The stock is trading near its longer-term resistance level and if longer term resistance remains intact we would expect the stock to fall back to test longer term support levels again by rule. The test of longer-term resistance is also a short signal according to rule, and it acts as a risk-control mechanism as well, so if resistance breaks higher any shorts initiated near resistance should be closed.

Given the tests of longer-term resistance that are occurring in shares of Adobe at this time, our combined technical analysis suggests extreme caution. Currently, resistance exists at $78.50, but this number will change as the stock moves and the trading channel changes, so update your information regularly.

Analysts are expecting aggressive and impressive growth, especially in 2016, but those numbers appear exaggerated on the surface, and given the recent growth trends an accelerated growth rate like that would definitely not be in line with recent trends. Recent trends have been positive, and the company has been recovering from the earnings trough it experienced in the third quarter of 2013, but not at a rate in line with what analysts are currently expecting for 2016. That raises some eyebrows because the PE multiple of Adobe is extremely high, and if the company is not able to match estimates as they currently exist, natural multiple contractions are likely. Our technical analysis warns us that if resistance holds, a decline to longer-term support for Adobe is likely as well, so tread with caution.

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